In this note I elaborate briefly on the case against the Fed pausing at neutral.
The pause at neutral was perhaps a useful construct during the early exit from ZIRP, when the Fed had an interest in slowing down the repricing. But even if we spot the neutralistas some quite extreme assumptions, the idea makes little sense, which people are starting to figure out now that the achievement of estimated neutral is believed to be close at hand.
One of the brokers has raised the point – quite correctly in my view – that a pause would generate a large easing of financial conditions. One issue here is that the Fed cannot coherently even make the case for a pause. If they know they are going to continue tightening later, then why stop now? Talk about your communication difficulty!
But this note is not about that. It is merely a review of the logical inconsistencies involved in pausing at estimated neutral simply because it has been achieved.
There is a case for the Fed pausing once a meaningful tightening of broader financial conditions has been achieved, particularly if that tightening were to come quickly, such that its effects could not be monitored in real time. Alternatively, the Fed would certainly pause or even reverse if growth were surprisingly to lose momentum in response to what has already been delivered – or if there were some external shock larger than we have so far seen.
But pause at neutral makes no sense.